Four views of the US financial system December 4, 2012 John Lester Partner Oliver Wyman
Summary Four views of the US financial system Business line view: Financial system businesses generate > $1 TN in annual revenue across five major business lines Structural asset-liability view: Financial gearing of real economy has increased, while securitization further multiplied claims within the financial system Comparative view: US financial system is big, unbundled, less bank-centric, and complex Evolutionary pressure view: Financial system innovations and practices have been driven by the wish to reduce the amount of credit evaluation that must be done Oliver Wyman 1
US financial services by business line Revenues by financial services business, total = $1.2 TN $BN, 2010 Corp. Insurance Retail Bank. $430 $355 $105 100% Trd Fin 80% 60% Property & Casualty SME Lending Consumer Lending Credit Cards Cash Mgmt Inv. Bank. $100 Corp. Fin. Equities Asset Mgt $175 Alternatives Institutional Prvt Banking 40% 20% Life Mortgage Deposits Lending Fixed Income Retail 0% 20% 40% 60% 80% 100% Source: Oliver Wyman analysis Oliver Wyman 2
Today, total financial claims are ~10 times GDP Financial assets held, by economic sector 2011 Financial system (43% of financial assets) Scale: 2011 GDP $15 TN Pensions Own: $10 TN Banks Own: $15 TN Firms Own: $19 TN Households Own: $50 TN Inv. Funds Own: $10 TN GSEs Own: $6 TN Insurers Own: $7 TN Money mkt Own: $3 TN Rest of FS Own: $11 TN Gov t Own: $4 TN Rest of world Own: $19 TN Fed Own: $3 TN Source: Flow of Funds Accounts of the Unites States Oliver Wyman 3
Thirty years ago, financial claims were less than 5 times GDP Financial assets held, by economic sector 1981 Financial system (34% of financial assets) Scale: 1981 GDP $3.1 TN Pensions Own: $0.8 TN Banks Own: $2.4 TN Firms Own: $1.8 TN Households Own: $7.0 TN Inv. Funds Own: $0.1 TN GSEs Own: $0.2 TN Insurers Own: $0.7 TN Rest of world Own: $0.5 TN Money mkt Own: $0.2 TN Fed Own: $0.2 TN Rest of FS Own: $0.4 TN Gov t Own: $0.6 TN Source: Flow of Funds Accounts of the Unites States Oliver Wyman 4
Nonfinancial sectors have taken on more debt per unit of economic activity Credit owed by US nonfinancial sectors, as a percentage of GDP 1981-2011 300% 250% 200% 150% 100% Government Businesses 50% Households 0% 1981 1986 1991 1996 2001 2006 2011 Source: Flow of Funds Accounts of the Unites States Oliver Wyman 5
while daisy-chaining of credit via securitization increased the credit multiplier applied to claims on the real economy Financial sector credit assets, as a percentage of credit owed by nonfinancial sectors 1981-2011 120% 100% 80% 60% 40% 20% Fed Pensions Inv. funds Insurers Broker-dealers Funding corps MMMFs Fin. companies ABS GSEs + pools Banks 0% 1981 1986 1991 1996 2001 2006 2011 Source: Flow of Funds Accounts of the Unites States Oliver Wyman 6
How the US financial system is different More credit intermediation via markets and nonbanks, less dominant role for banking system Lots of small banks GSEs Subsidized mortgage asset funding Hold mortgage credit risk, and significant amount of prepayment (convexity) interest rate risk Many different regulatory bodies, but increasingly same rules for major players BHCs (including absorbed/converted dealers and finance companies), nonbank SIFIs, foreign IHCs: similar prudential requirements Orderly Liquidation Authority, the universal (in)solvent Big domestic economy Oliver Wyman 7
US world s most credible bank guarantor Assets as a percentage of home country GDP for world s largest banks 2011 Switzerland Netherlands Spain France UK Germany Italy China Japan US 106% 95% 76% 54% 50% 94% 83% 64% 50% 70% 28% 56% 29% 23% 23% 22% 39% 31% 27% 11% 10% 8% 7% 165% 146% 215% 0% 50% 100% 150% 200% 250% Source: Bankers Almanac, Economic Intelligence Unit Oliver Wyman 8
Evolution of US financial system has been driven by the desire to reduce (or avoid) the burden of credit evaluation Technology Examples Associated concerns Collateral Credit rating Tranching / priority of claims Credit guarantees Liquidity enhancement Repo Sec lending Prime brokerage Corporate, government, ABS ratings Consumer credit scores (e.g. FICO) Bank liability structure (equity, sub debt, senior debt, deposits) Private label ABS CDOs, CLOs Deposit insurance Monoline bond insurance Implicit guarantees (GSEs, investment banks, bank creditors) Agency MBS securitizations ETFs Money market mutual funds Asset price and liquidity risk Operational risk Substitutes idiosyncratic credit relationships for more systematic market relationships Model error Moral hazard Moral hazard Model error Principal-agent Conflicts of interest Moral hazard Asset liquidity risk Oliver Wyman 9
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